Posts Tagged ‘municipal bonds’

It couldn’t come at a worse time.  The 53 Gulf Coast counties in Florida, Alabama, Mississippi, Louisiana and Texas look forward to peak summer months when tourists flock to beach resorts, casinos and summer homes.  This year the tourists are staying away.  Revenues related to tourist spending and waterfront development projects are likely to drop.  The Bureau of Labor Statistics just issued a report detailing the concentration of jobs related to the hospitality and leisure industries.  Of interest, the Mississippi coastline stood out with a 22% concentration of jobs in these industries compared with 14.8% in Gulf Coast Florida and 12.8% nationally (percent of private sector jobs).  In terms of the number of jobs, Pinellas, Lee, Sarasota and Collier counties in Florida; Harrison, Mississippi; Mobile, Alabama; Jefferson and Orleans parishes in Louisiana stand out.   BLS calculated a second indicator of concentration, a “location quotient” which measures the multiple over the national average employment concentration in these industries.  We draw your attention to this valuable report to assess the bonds in your portfolio.

Source: Bureau of Labor Statistics

June 1st marks the beginning of hurricane season.  It’s been quiet for a few years but forecasters are predicting a more active 2010 season.  Here are a few thoughts for analyzing the links to municipal bonds.  Gray and Klotzbacher of Colorado State University operate the Tropical Meteorology Project believe that 2010 will be a “significantly more” active year, relative to historical averages. 

Information obtained through March 2010 indicates that the 2010 Atlantic hurricane season will have significantly more activity than the average 1950-2000 season. We estimate that 2010 will have about 8 hurricanes (average is 5.9), 15 named storms (average is 9.6), 75 named storm days (average is 49.1), 35 hurricane days (average is 24.5), 4 major (Category 3-4-5) hurricanes (average is 2.3) and 10 major hurricane days (average is 5.0). The probability of U.S. major hurricane landfall is estimated to be about 130 percent of the long-period average. We expect Atlantic basin Net Tropical Cyclone (NTC) activity in 2010 to be approximately 160 percent of the long-term average. We have increased our seasonal forecast from the mid-point of our early December forecast.

The Tropical Meteorology Project has a detailed the probability of landfall of major hurricanes for each of the counties from the tip of Texas, along the Gulf Coast and up the Atlantic coastline to Maine.  There are pockets of high probability and pockets where hurricanes rarely hit.  The data is downloadable into a spreadsheet — if you navigate to the “landfall probability table”.  The project’s website also has background on their methodology and the full analysis of their predictions for the inquiring mind.  From this you can develop a methodology for analyzing hurricane risk in coastal communities. 

Citizens Property Insurance Corporation, a state insurer in Florida, was set up to be a “last resort” coverage for wind damage when private insurance fell apart.  The CPIC has grown to become the major insurance provider in the state and is controversial among property-owners.  The St. Petersburg Times recently commented:

Citizens, the state’s largest insurer with about 1 million policyholders, and the state’s Hurricane Catastrophe Fund, which sells reinsurance to insurers, are in better financial shape than they have been entering some previous hurricane seasons. But they are far from being able to handle the worst hurricanes, and after a large storm Floridians would be paying huge assessments and begging for help from the federal government. There has to be a better way.

We agree.  Single-state catastrophe insurance makes little sense.   Concentration of risk is a classic red flag in credit analysis, and a this program is rife with concentration.  A “cat” insurance product would balance locations that draw on capital at times when other places have lower risk, producing on-going premium and steady capital.     Unfortunately, political boundaries and the lack of inter-state collaboration makes such a program difficult.  A multi-state program  (best would be international) would balance the risks of earthquake, hurricane, flood and tornado (not to mention man-made disasters).  The Insurance Company Institute has an excellent discussion of the issues and current proposals for covering mega-disasters.    
 
Many are linking the oil spill in the Gulf with the coming hurricane season.  See the New York Times article on this.  John Mousseau of Cumberland Advisors recently wrote a chilling commentary about potential problems along Gulf Coast communities from the oil spill. 
 
The long-range consequences of the spill and how a serious hurricane would interact are not clear.  While the spill in Valdez, Alaska and Hurricane Andrew in Homestead, Florida actually created a surge in economic activity, we are less optimistic this time around. 

See this post on Reuters for discussion about Antioch, latest city in California to talk bankruptcy.  There is a bill, sponsored by state senator Mendoza, AB155, that would require cities to go through the state (via the California Debt and Investment Advisory Commission, CDIAC).  The bill was referred last week by the Senate appropriations committee — but now appears there will be some further review.  The pros and cons line up as follows;  cities strongly against state involvement in order to preserve local autonomy; unions and bondholders in favor in order to prevent reduction of obligations, whether they are union contracts or debt obligations.  Interesting line-up.  Many states have had oversight programs for their distressed communities for years.  Distressed designation may trigger  grants or aid to distressed municipalities that would not be present in a federal bankruptcy.  Some states map out a “receivership” process that gives the state certain intervention rights to reorganize the municipal government and bring finances back into balance.  Cities oppose any additional intervention by the state that encroaches on their powers.  Pro-union forces in the legislature want to prevent the cities from filing bankruptcy since it may result in reduction of  contract provisions (which was determined to be possible in the Vallejo case).  So far the pension albatross has yet to be tested.  According to Antioch’s 2009 audit the city is obligor on about $27 million certificates of participation, paid through lease agreements, current underlying ratings are Standard and Poor’s “A” and there is MBIA insurance on at least some (maybe all, we didn’t check each series) of the certificates.

Why is the municipal market selling at such a premium?  I have been asked this question several times in the last few weeks — not by career municipal analysts at mutual funds or rating agencies, but sophisticated investors who are trying to make sense of the asset class.  The counterpoint is coming from writers forecasting the collapse of municipal bonds.  How do we reconcile this disconnect?  For one, the supply/demand dynamics have changed significantly since a year ago.  Aside from fear of tax increases propelling more buyers into the tax exempt shelter, there is another factor: BABs.  The Build America Bond program has grown to $97 billion, as of the end of April, according to Treasury’s May 12 release — or 20% of the municipal market since the program’s inception in April 2009.  (BABs are taxable municipal bonds; the borrower receives a 35% reimbursement from the federal government – on the theory that this creates a neutral rate compared with tax exempt bonds.)  But this 20% understates the recent trend.   A closer look shows that BABs issuance in recent months hovered around 25% of the new issue market.  All taxable municipal bonds issued in 2010 through April amounted to a whopping 33% of the market according to the Bond Buyer market statistics.  These changes have expanded the buyer base for municipals to those wanting long term public sector debt, but not affected by the US tax code, such as foreign buyers, pension funds and certain corporate investors — limiting supply of paper for the traditional  tax exempt investor.  This is not to mention that most BABs are structured at the long end of the curve, squeezing tax exempts into the shorter end — since most issuers will structure both into a single offering.  (Except of course for Illinois, which prohibits a mixed structure –hunh?)   The pattern is likely to continue in the foreseeable future as Congress extends the taxable BAB structure, although market dynamics may shift modestly when the subsidy is reduced to a more logical 28%.

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So how’s the economy?  The recent Bureau of Labor Statistics jobs report was encouraging.  We created 290,000 jobs last month.   Unemployment notched up to 9.9%, but this is to be expected at the early stages of recovery.  As signs of recovery emerge, more people enter the job market, and if that’s proportionately more than new job creation, the unemployment rate will go up.  (The unemployment rate expresses the ratio between the number of jobs and number of people counted as part of the labor market.  So if everyone stopped looking for work, unemployment would go down.)  In fact, 805,000 people entered the labor market last month far more than the number of jobs created. 

Not to be a downer, but many of the new jobs are temporary hires for the decennial Census count.  According to the BLS, the federal government employed 154,000 people for the census count as of April, an increase of 66,000 over the prior month.  This increase followed hiring of 48,000 in February.  Don’t get me wrong, these jobs will infuse spending into the economy, ease unemployment for many and get an important count accomplished.  But they are temporary jobs that will peel off around the same time that other federal stimulus programs wind down. 

Another factor slowing down the recovery is the lack of migration.  The housing mess is a contributing factor.  We noted in a previous post the first-time reversal of migration patterns since those statistics were collected.  We have always been a nation of restless movers – opportunity seekers since the founding of the U.S.     In large part this has contributed to the active municipal bond market for infrastructure growth and development.  As jobs moved from north to south, east to west, city to suburb, people and development followed.   In the current economy, this trend has reversed in many places. 

William Frey, the noted demographer, stated in a recent report for the Brookings Institution:

The detailed 2010 census results won’t be available for another year. But this week (back in March, ed.) the Census Bureau unveiled its latest population estimates for metropolitan areas and counties for the year ending last July. What they show is a country that is demographically standing still.

Last week, the Census bureau reported an uptick in the migration rate in 2009, from 11.9% to 12.5%.  But the majority of movers went from one county to another within the same state while job moves are typically inter-state.  Further, renters moved at five times the rate of homeowners.   Homeowners, already battered by the housing downturn are finding it difficult to move to better jobs (or jobs at all) when they cannot sell their homes.

Here’s a podcast with the author on Derivactiv, Municipal Market Pulse; a bit long but covers a lot of ground:  http://www.derivactiv.com/Podcasts/Natalie_Cohen_Muni_Bond_Market_Is_Not_Systemic04-20-2010.mp3

Municipal Market Pulse podcasts, produced by Derivactiv are also available on iTunes (for the ubernerds like me; ha, you thought I was listening to music)

The author on Bloomberg TV discussing the coming municipal market collapse (not).

The financial reform proposals, designed to eliminate systemic risk, could actually trigger another meltdown upon the bill’s passage.  This is due to the ratings notching approach that has given rating credit to government support since the meltdown.  A change in the expectation of support – both emergency and on-going would result in ratings downgrades for certain banks.  Standard and Poor’s for example, gives a three notch upgrade to the counterparty ratings of Bank of America Corp., Citigroup Inc and Morgan Stanley and two notches to Goldman Sachs and UBS AG.  Reverting to a lower stand alone rating could trigger collateral calls, terminations or other nasty events, not unlike what we have seen over the last three years.  My bank analyst colleagues are more sanguine about the likely outcome.  They suggest the banks would raise more capital, and by the time of passage, the underlying stand alone ratings could be improved.  But the House bill requires bondholders to take it on the chin before federal monies could be used.  And if the goal is to withdraw federal support, where would the capital come from?  While this issue may be better-understood by bank analysts I thought this should e brought to the attention of the municipal finance readership here.  Caveat counterparty.

The tables below are for contextual reference as state and local governments face draconian spending cuts.   The combination of public policy with the several bubble periods over the last twenty-five years has created a toxic brew.  Some state and local governments are valiantly trying to tackle the issues while other legislatures and councils are more interested in fist pounding.  For those involved in financial analysis (as well as taxpayers) a careful eye is called for. 

State and local spending grew dramatically during the post-Reagan years of the “Program for American Recovery”.  A historic devolution of responsibilities from the federal government to state and local government was coupled with overall economic growth during this period.  I have commented on this issue in prior posts and the presentation I gave at the recent analysts’ conference.  The following tables are expanded to include the 1982-1992 decade.  The first set of columns show dollar increases in 1982 constant dollars.  To account for population changes from migration, which naturally cause increased spending for schools, infrastructure, healthcare, etc. the second set of columns shows the constant dollar increase in per capita spending.   Embedded in these figures are a complex set of decisions on spending, and different approaches to governance, not to mention divergent demographic and economic profiles across the states. 

click image for independent table

click image for independent table

click table for independent image

click table for independent image

 

Florida and Nevada top the list in the 1982-1992 decade with spending increases of 105% and 108% respectively.  Florida’s population grew by nearly one-third during this time while Nevada grew by more than 50%.  Per capita spending in Florida increased nearly 58% while Nevada increased 36%. 

On October 19, 1987, Black Monday, the stock market crashed,  followed by the savings and loan crisis and the Gulf War which combined to hit state and local budgets hard.  Mid-term elections during the Clinton administration resulted in Republican control of Congress and the “Contract with America” which further devolved responsibilities to state and local governments.  Some governments slowed their spending increases in the 1992-2000 period.  On a per capita (constant 1982 dollar) basis spending actually declined in some places.  (Note that these are combined state and local figures from the Census Bureau — most other sources, such as Pew, Rockefeller and Center for Budget Policy Priorities focus only on the states.) 

Population growth figures allow some analysis of the changes.  For example, Nevada had nearly 50% population growth which helps to explain a 7% decline in per capita spending during the 1992-2000 period.  New Jersey, in contrast, hard hit by the recession, had only a 7% increase in population but had a nearly 2% decline in per capita spending over the period.

(For the detail oriented reader, there is a minor change in the numbers since I adjusted for 2007 population — the prior tables used 2008 population. Data source: Census Bureau and Bureau of Labor Statistics.  Note that spending includes current year payments for retirement and health benefits but not capital outlay.)

This link from a recent release by the Brookings Institution, Robert Puentes comments on the New Jersey and Virgina transportation funds.  New Jersey’ transportation trust fund will be spending all of its revenues on debt service by 2011; Virginia’s new governor too, suffers lack of funds for infrastructure improvements.  Concerning gas tax as a mechanism for raising funds, New Jersey and Virginia are among the lowest in the nation.  Granted, New Jersey heavily tolls its turnpike drivers.  The website, GasBuddy shows a map by county of prices around the country — updated every 15 minutes.  New Jersey is clearly on the low end, Virginia a bit higher but not nearly as high as New York or California….

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